Accounting Standards Codification 420 (ASC 420) was released to address the more specific topic of recording liabilities for exit or disposal cost obligations.
Another commonly used term for these types of costs are restructuring costs, and are particularly risky from a financial accounting standpoint due to the potential for abuse. One way in which these have been abused in the past is through creating what are referred to as cookie jar reserves, which the company will create an overly large liability as a result of the restructuring in order to smooth out future earnings.
Restructuring Costs under ASC 420
This GAAP standard typically covers two types of restructuring charges – those associated with an anticipated business combination, as well as the accounting for onetime termination benefits (severances), employee relocation costs, lease termination costs, and facility consolidation costs.
There are certain rules which exist for when the technical qualifications of a onetime arrangement exist. All of the following rules must be met in order for it to be considered to be in place:
- Management has committed to the plan
- Number of employees are specified, their job functions, locations, and expected termination dates
- Plan states the terms of the severance packages in enough detail for employees to understand the amount and type of benefits they will receive upon termination
- Remaining actions to complete the plan must indicate no significant changes to it will be made
- The terms of the plan must have been communicated to the employees
If certain costs related to relocating are expected, there will be a liability which is recorded associated with the cost to terminate any contracts which have been made (for example, leased locations) and should be recorded at fair value. A liability should also be incurred for any amount of time that costs will be incurred that bear no economic benefit to the entity.
When these costs are incurred, there are also disclosure requirements which must be met in order to provide adequate information. These costs should be separately shown in income from continuing operations before taxes, and any amounts related to costs associated with discontinued operations should they exist. From the period of the initiation of the disposal plan until execution, the following should be disclosed:
- Describe each of the activities to take place, and their related completion dates
- For each major category, the amount expected to be paid, amount incurred to date, amount incurred in this period, amount for the entity and each reporting segment, and the expected date of completion
- For each major category, reconcile the change in liabilities with the expenses incurred
- Any reasons for adjustments made to the liability amounts
- Disclose the line items in the income statement which the exit costs are aggregated
- If there are costs which are not accrued due to inability to estimate the amount, disclosure of what the activity is and why it cannot be estimated
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